Soft landings all around?

On Thursday the US Bureau of Economic Analysis published preliminary data showing that the US economy continued to expand at a relatively subdued pace in Q2.  Today Statistics Canada reported that real GDP grew in May but probably shrank slightly in June. Are the two countries' central banks close to achieving the "soft landing" they have been aiming for? 

The US data are relatively clear-cut, though it should be noted that this is a preliminary estimate, with more complete information to come on August 30. Real GDP rose at a 2.4 percent annual rate in Q2, up from 2.0 percent in Q1.  The slight acceleration in growth in part reflected rising business investment, which will not be unwelcome to the Fed. Higher inventory accumulation may be a consequence of the reported slower growth in consumer spending, though there is little real evidence that the US consumer is running out of steam.

The Canadian numbers are a bit more difficult to parse, and likely to remain that way for another month or two at least. The 0.3 percent month-on-month rise in GDP  in May was slightly lower than StatsCan's initial estimate of 0.4 percent, but there were special factors at play. While the service sector showed robust 0.5 percent growth, the overall economy was held back by a sharp fall of 2.1 percent in the energy sector, reflecting the very early and severe start to the forest fire season in the main energy producing Provinces. 

The initial estimate of a 0.2 percent decline in June seemingly occurred despite a somewhat surprising rebound in oil and gas production, as wholesale trade and manufacturing output apparently declined in the month. Even with the pullback in June, it appears that the Canadian economy yet again stayed well away from the recession that the media have been craving for more than a year now: firm data on this will not be available until September 1.

Canadian monthly GDP data will remain hard to interpret through Q3. The strike at ports in British Columbia obviously hit national GDP in the first half of July. It is always hard to know how long the economy takes to rebound from such shocks, but experience says it usually happens much faster than expected. If it turns out that real GDP fell in July, it is a near-certainty that growth for August will rebound sharply, but of course that will not be knowable for several months.  

So, are the Fed and the Bank of Canada likely to assume they have achieved the fabled soft landing?  In both countries, inflation has been falling sharply for better than a year, even though the economies are continuing to expand. Labour markets are tight by historical standards, yet wages remain well-behaved. This is not how the textbooks - well, at least the chapter on the Phillips curve -- say things are supposed to happen.  One could hope that the central banks will not be too vocal about taking credit for the way things seem to be turning out -- and one could also hope that they are revisiting some of the models to try to figure out how and why things have actually worked out so well. 

Nothing new to say

The US Federal Reserve today boosted the fed funds target range by 25 basis points, bringing it to a 22-year high of 5.25-5.50 percent.  There were no dissenters from the FOMC's decision. The accompanying press release is remarkable for its lack of any new thoughts on the evolving economic situation: it's almost as if the FOMC is bored with the whole thing and wishes everyone would just go away for the summer.

Purely for the record, these are the key points, not one of which is in any significant way different from what we have heard in the last few months. A few key quotes: 

• "economic activity has been expanding at a moderate pace. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated".
• "In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments".
• "The Committee is strongly committed to returning inflation to its 2 percent objective".
• "The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals".

Although it is not new, perhaps it is the last of those quotes that deserves the most focus. The fact that such wording is still there after so many months implies that the Fed has still not seen convincing evidence that its tightening has gone far enough. It is impossible to guess exactly what would convince the FOMC to change course, but a couple of weak jobs reports and firmer signs of slowing core inflation would no doubt move things in that direction.  As things stand, it is impossible to rule out another 25 basis point hike at the September 19-20 FOMC meeting, but there is a lot of data on the docket before we get to that date. 

Canada CPI: in the target range, for now

Canada's headline CPI came in slightly lower than expected in June. Data from Statistics Canada show that prices rose 0.1 percent in the month, down from 0.4 percent in May. This lowered the year-on-year figure from May's 3.4 percent reading to 2.8 percent, the lowest since March 2021. While it has become something of a habit to talk of the Bank of Canada's 2 percent inflation target, the official target is actually a range of 1-3 percent, which has now been hit.  However, it is highly unlikely that the Bank will consider today's data as evidence that its job is done.

Base effects continued to be a big part of the story in June, probably for the last time: June 2022 represented the peak of the inflation spike so there are no more outsized numbers left to fall out of the index. Specifically it was the cost of energy that helped push the headline reading lower, with gasoline prices down 21.6 percent in June from a year ago.*  CPI excluding gasoline was 4.0 percent higher in June than a year ago.

Two key components of the index continue to be responsible for most of the upward pressure. Food prices actually ticked slightly higher on a year-on-year basis; food purchased for consumption at home rose 9.1 percent from 9.0 percent in May, while restaurant prices slowed marginally. However, the monthly increase in food prices was a more reassuring 0.1 percent.  Mortgage costs also continued to push overall CPI higher, rising 30.1 percent from a year ago; this is, of course, the component of inflation that is most directly in the Bank's control.

The most widely-quoted measure of core inflation, CPI ex food and energy, remains above the target range, standing at 3.5 percent in June. As for the Bank of Canada's preferred core inflation measures, all three edged lower in June, but their mean value remains above 4 percent, suggesting the Bank has more work to do.

Today's data may be as good as it gets for the Bank of Canada (and Canadian consumers) in the near term. The end of the downward pressure from the base effect makes it likely that further progress toward 2 percent will be slow -- which is clearly the Bank of Canada's view, given its recent forecast that that level will not be reached until 2025. Some analysts are suggesting headline CPI will tick back above 3 percent in the next couple of months. This may well be the case, even though underlying inflation pressures are evidently easing. For sure, there is no reason for the Bank to contemplate rate cuts any time soon. 

* Friendly advice: don't hold your breath waiting for the Conservatives to stop parroting the line that higher fuel prices, supposedly the result of carbon tax hikes, are the main factor pushing inflation higher. 

US inflation data for June: that's better

The Bank of Canada may have sounded strikingly hawkish when it raised rates this morning, but the latest US CPI data suggest the Fed may soon be able to adopt a somewhat softer tone. Data from the BLS show that headline CPI rose 0.2 percent in June, which served to lower the year-on-year increase to 3.0 percent -- down from 4.0 percent in May and a far cry from the peak of 9.1 percent recorded exactly a year ago. Shelter costs, up 0.4 percent in the month and up 7.8 percent from a year ago, were the largest contributor to the month-to-month increase and accounted for fully 70 percent of the annual increase in headline CPI. 

Core CPI also slowed in the month, although it remains well above the Fed's 2 percent goal.  the month-on-month increase in CPI less food and energy was 0.2 percent, the lowest monthly figure since August 2021.  The year-on-year increase in this measure is 4.8 percent, with much of the discrepancy between annual headline and core resulting from the sharp fall in energy prices, down 16.7 percent from a year ago.  

The persistently higher gains in core CPI will complicate the Fed's decision making in the near term. However, the somewhat perverse role played by energy prices in seeming to push up core inflation may make it appropriate to focus more than usual on the headline number, which is, after all, the index that the Fed is supposed to be targeting at 2 percent. Early signs of a slowing labor market and tame growth in wages suggest that the policy measures taken to date are having the desired effect. One further rate hike cannot be ruled out, but all of a sudden it looks as though the Fed may be nearer the end of its tightening cycle than the Bank of Canada is.

Bank of Canada still sounds hawkish

As expected, the Bank of Canada raised its overnight rate target by a further 25 basis points today, bringing it to 5.0 percent. It's remarkable to note, especially for those of us old enough to remember the ultra-high interest rate era of the 1980s, that this is the highest the target has been since 2001. 

The press release is longer than usual and the Bank's take on the current situation is further fleshed out in an updated Monetary Policy Report.  In brief, the Bank sees that the Canadian economy has been growing more quickly than previously forecast, so excess demand and labour force tightness persist. Growth is expected to be slower over the next twelve months, but further progress in reducing inflation will be slow, with a return to the 2 percent target, previously hoped-for by sometime in 2024, now not expected until mid-2025. Some key quotes:

Regarding real growth: Canada’s economy has been stronger than expected, with more momentum in demand. Consumption growth has been surprisingly strong at 5.8% in the first quarter. While the Bank expects consumer spending to slow in response to the cumulative increase in interest rates, recent retail trade and other data suggest more persistent excess demand in the economy.

Regarding immigration levels, a new topic for the Bank: Strong population growth from immigration is adding both demand and supply to the economy: newcomers are helping to ease the shortage of workers while also boosting consumer spending and adding to demand for housing.

Regarding inflation: Inflation in Canada eased to 3.4% in May, a substantial and welcome drop from its peak of 8.1% last summer. While CPI inflation has come down largely as expected so far this year, the downward momentum has come more from lower energy prices, and less from easing underlying inflation......CPI inflation is forecast to hover around 3% for the next year before gradually declining to 2% in the middle of 2025. This is a slower return to target than was forecast in the January and April projections. Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability.

Given this analysis, today's rate hike was in effect a foregone conclusion:  In light of the accumulation of evidence that excess demand and elevated core inflation are both proving more persistent, and taking into account its revised outlook for economic activity and inflation, Governing Council decided to increase the policy interest rate to 5%...... we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the 2% inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Ahead of today's meeting, there had been some speculation that a rate hike this month would likely mark the end of the current tightening cycle. The tone of today's statement, and particularly the startling prediction that CPI will not return to the 2 percent target for another two years, makes that rosy outlook seem very unlikely.  Markets are now pricing in another 25 basis point hike at the Bank's September 6 Governing Council meeting. As always, the actual decision will depend on the data flow, but at this point it is hard to see any other outcome. 

Early signs of a jobs slowdown, maybe

The remarkably strong ADP employment numbers released on Thursday had set markets up, and not in a good way, for a strong non-farm payrolls report. As it turned out, the jobs data for June released by the BLS this morning were on the soft side of expectations, and significant downward revisions of the previous two months of data seem to suggest that the US employment market is starting to soften. 

According to the BLS, the US economy added 209,000 jobs in June, the thirtieth consecutive month of rising employment. This was slightly below market expectations for a gain of more than 220,000.  Moreover, the figures for the two previous months were revised lower by a total of 110,000 jobs. The rolling three-month average job gain has clearly slowed since the start of the year, though it remains above its pre-pandemic pace.

Importantly for policymakers, wage gains remain well-contained. Both the 0.4 percent month-om-month gain and the 4.4 percent year-on-ear gain in average hourly earnings in June were unchanged from the previous month's data.  The absence of wage pressures may reduce the temptation for the Fed to start raising rates again at the FOMC meeting on July 25/26, but markets are not convinced that the tightening cycle is over. The steep falls on Wall Street that followed yesterday's ADP report have not been recouped in Friday morning trading. 

Meanwhile in Canada, the jobs data look rather different, but no less interesting. Employment grew by a very strong 60,000 in June, and that headline number may actually understate the strength in the jobs market, as full-time employment rose by 110,000 in the month. 

Given the growth in employment, it is somewhat surprising to note that the unemployment rate ticked up to 5.4 percent in June from the previous month's 5.2 percent. The explanation lies in the fact that the labour force grew by a remarkable 114,000 in the month. StatsCan does not elaborate on this, but it seems likely that the huge gain in the labour force is connected to Canada's current high levels of immigration, with upwards of a million newcomers arriving every twelve months.  In prior months it had been remarkable how little impact the surge in numbers had on the employment situation, but if that is now starting to change, the jobs market could deteriorate quite rapidly in the coming months as higher immigration persists.

As in the United States, the trend in wage gains is a key consideration for policymakers.  On this front, today's report was reassuring for the Bank of Canada. The growth in average hourly earnings slowed to 4.2 percent in June from 5.1 percent in May. the slowest gain seen since May 2022.

The Bank of Canada's rate decision next week is complicated. Wages are in check; employment is strong, but there are signs that the tightness in the labour market is easing, partly as a result of high immigration levels.  And there is one wild card: the strike by dockworkers in British Columbia is nearing the end of its first week, with no signs of a breakthrough. Given the importance of the ports of Vancouver and Prince Rupert to the national economy, it will not be long before the effects on output and employment are felt more widely. A rate hike next week still seems more likely than not, but a renewal of the "conditional" pause is not out of the question.